The written put option is covered if the put option writer is also short the obligated quantity of the underlying security. The short put is naked if the put option writer did not short the obligated quantity of the underlying security when the put option is sold.
CommissionsFor ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.However, for active traders, commissions can eat up a sizable portion of their profits in the long run.
By having long positions in both call and put options, straddles can achieve large profits no matter which way the underlying stock price heads, provided the move is strong enough. As explained in our previous article Long Short Options Terminology, when you SHORT an option, it means you are SELLING an option (not the underlying stock or index).
To understand this with an example: First look at the PINK colored graph - that is the basic payoff function for Short Call Option without considering the price or premium of the call option. So what you do is SHORT (or sell) Microsoft call option with a strike price of $30 and from this sale you receive $5.
So you can see that as the price of the underlying continues to increase, your losses continue to increase as well.
The synthetic long put is so named because the established position has the same profit potential as long put.
The put option writer is paid a premium for taking on the risk associated with the obligation.
When the options trader is bearish on particular security, he can purchase put options to profit from a slide in asset price. A put option contract with a strike price of $40 expiring in a month's time is being priced at $2.
With this crash in the underlying stock price, your put buying strategy will result in a profit of $800.
See our long put strategy article for a more detailed explanation as well as formulae for calculating maximum profit, maximum loss and breakeven points. Put option writers, also known as sellers, sell put options with the hope that they expire worthless so that they can pocket the premiums.
Put spreads limit the option trader's maximum loss at the expense of capping his potential profit at the same time. Hence, you receive money from that.Short Call Option Payoff FunctionHere is the Payoff Function for Short Call Option.
So, let's say Microsoft stock (not the microsoft option) is currently trading at $30 per share. The price of the asset must move significantly below the strike price of the put options before the option expiration date for this strategy to be profitable. What this tells you is that if the microsoft stock remains below the strike price of $30 on the expiry day, then you will keep the entire $5 you got from the sale of Microsoft call option - as indicated by the horizontal flat line of the RED graph. Since the strike price is $30, and the stock price is ending at $31, you will be required to pay the buyer of the option $1 ($31- $30).
Since each put option contract covers 100 shares, the total amount you will receive from the exercise is $1000.
However, If the price of microsoft on the expiry day is higher then the strike price of $30, then your profits will start coming down in a linear fashion - as indicated by the 2nd part of the slanting RED graph. As you had paid $200 to purchase this put option, your net profit for the entire trade is $800. The option will get exercised by the buyer and you will be required to pay the difference between the stock price ($70) and the strike price ($30). Breakeven point for Short Call OptionBreakeven point is basically the no profit no loss situation. On the expiry date, since the underlying price ($35) is higher than the strike price of ($30), the option will get exercised by the buyer and you might have to pay brokerage for the option getting exercised.
Although on exercise, you will give back $5 to the buyer which you got while selling the call option, but the brokerage might be charged on both the legs so that will result in net loss for you.
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